Markets too gloomy

Stock markets are excessively gloomy and fixated on the macroeconomic threat of contagion from a weak US economy, according to Ian Ormiston, European investment director at Resolution Asset Management.

Ormiston, manager of the ResolutionAsset European Smaller Companies fund - which is first percentile in its sector year to date - believes fears of a further market collapse are overdone and fail to take into account the strength, prospects and high cash levels of companies across the Continent.

Ormiston believes small caps in particular are more attractive than many believe, arguing that the relative re-rating of small caps that ran from 2000 until last summer was as much about the de-rating of large caps from their dot-com peak as it was about their smaller counterparts.

Although he concedes that small caps remain more expensive than large caps, he argues that both are cheap, with small caps relatively attractive due to their lower exposure to toxic investments, tendency to operate within resilient niches and the increased likelihood that M&A activity may return on a smaller scale due to greater caution and availability of finance. He points out that two companies in his fund - AWD, a German IFA, and customer service outsourcer D+S Group - have received cash bids since the turn of the year and expects similar moves over the coming months.

Despite his optimism, however, Ormiston says the extent of investors' willingness to return to small caps will hinge on European economies' response to US Federal Reserve rate cutting, and the resulting shift in asset allocation. Nevertheless, he believes investors have overestimated the challenges facing small caps, arguing that large international companies are far more exposed to diverse economic headwinds.

He says: "Small caps are at a premium to large caps but are relatively more attractive due to their lack of subprime exposure and likely return to M&A activity in the coming months. It is also easier to gain exposure to resilient niches in small caps - a key focus for us - and easier to avoid problems areas. In addition, Europe remains a relatively safe place to do business, with fewer cyclical excesses than in the Anglo-Saxon world. Markets are simply too gloomy and we believe things are not as bad as people will have you believe."